December 14, 2006
By BARBARA TRAVERS
Organization: The Brookings Institution
Position: Senior fellow
Anthony Downs has been involved in private, nonprofit research related to public policy throughout his career, advising public and private decision makers on real estate investment, housing policy and urban affairs. He has been with the Brookings Institution since 1977, and recently served as a visiting fellow at the Public Policy Institute of California.
Downs has a doctorate in economics from Stanford University and is the author or co-author of 24 books and more than 500 articles, including: “Still Stuck in Traffic,” “Growth Management and Affordable Housing: Do They Conflict?” and “The Cost of Sprawl.”
We’ve seen investors pay record prices for real estate properties. What is fueling this movement?
There has been the largest flow of capital in the history of this country since about the mid-1990s, particularly after the year 2000 when the stock market crashed. In short, investors saw that real estate was clearly outperforming stocks and bonds, so capital flooded into real estate markets, both residential and non-residential. That caused an enormous rearrangement of the landscape of real estate.
The Northwest is a high-priced part of the country but fundamentally it is not different than other parts of the country. The flood of capital has affected the whole world, not just this country.
How long will this last?
I’m surprised it has lasted as long as it has. One of the indications of the amount of capital that is going into real estate is what happens to the price of real estate investment trusts (REITs). These stocks have moved in the opposite direction from the rest of the stock market since the 2000 crash. REITs took off and have tripled in price. In 2006, I thought that money would start to flow out of them. But the opposite has occurred and they have been at all time highs.
As long as the money stays available, there will be new development. I see a three-phase cycle in real estate: a development boom followed by an overbuilt period followed by a gradual space absorption period. What we have now is a different cycle because the money came in even though there was overbuilding when demand collapsed in 2000.
The oversupply of space didn’t stop prices from rising and that’s leading to a development boom. It’s already started in industrial, and if that gets going at a full clip that will lead to overbuilding, especially if the economy slows down next year. And that could lead to a recession in 2008 or 2009. The past doesn’t have to repeat itself exactly, but it could happen especially if there is a lot of overbuilding.
Any thoughts on the recent acquisition of Equity Office Properties, a REIT, by Blackstone Real Estate Partners, said to be the largest private equity deal in history?
One of the impacts of all this money coming into real estate is the rise to power of private equity funds. Private equity funds are different than REITs because they are short-term funds with property bought then sold at the longest seven years out making a profit on the increase of prices. REITs are mostly founded by people intending to keep them for long periods of time as operating properties making money off of the operation rather than the increase in price.
We’ve just gone through the greatest period for selling real estate property in history, or we’re still in it, as EOP obviously thinks. We have probably passed the peak of the market, but it may last awhile because there’s still money pulling into real estate, in particular because REITs are now being formed for the first time in foreign countries.
The housing market is losing momentum and control is moving towards the buyer. How does that impact not only the real estate market, but also the economy as a whole?
Another obvious impact of the flow of capital into real estate is the stimulation and increase of housing prices. That led to the enrichment of people who own homes. If you look at the total balance sheet of American households in 1990, $6.5 trillion was in real estate. Today it’s $20 trillion. Homeowners treated these equity gains as income and savings. They borrowed against their gross equity, which has gone up tremendously as the borrowing rate remained constant. Anyone who owned a home during this period has gotten wealthier whereas people who didn’t found their standard of living fell dramatically.
The increase in housing equity was a major factor stimulating household consumption. That’s one of the reasons the economy has held up so well. Homeowners, who are now 69 percent of all households, borrowed against their housing equities mostly in the form of mortgages and refinancing. They took money out, tax free, and used it to support their consumption desires. This has changed the relation between housing prices and income in this economy. Incomes have hardly gone up at all whereas housing prices have gone up tremendously.
The generally expansionary force of American housing markets is about to lose its momentum in the next year or two. As interest rates rise, new construction and sales will decelerate. Slowing housing markets will have a slowing impact upon many aspects of the American economy, especially personal consumption.
How does the world stage factor into this?
I believe that one of the major causes of this huge increase of money supply has been the rise of the Asian low-wage labor force. Over the past 20 years, the increase in industrialized laborers, particularly in China and India, has been huge. As masses of skilled labor workers entered into industries, the world’s industrialized labor force has expanded by at least 30 percent, The Brookings Institution estimates. At low wages. That kept a downward pressure on manufacturing costs around the world and prevented inflation from occurring.
Even before the stock market crash of 2000 there was concern that the possibility of the huge entry of Chinese workers into the world’s industrial manufacturing businesses was going to cause a downward pressure on prices and cause deflation. So, many of the central banks in the world began to increase the liquidity they were supplying in their economies (to) keep interest rates low. But the real thing that caused this to happen in spades was the 2000 stock market crash in the U.S., which turned out to be a worldwide event. That stimulated the tremendous housing boom throughout the world because it became possible to borrow money at cheap rates. So people borrowed money and bought houses, which caused a boom in housing prices and production in all of the developed countries of the world except Germany.
So, ironically, the expansion of low-wage workers in China that people were complaining about because they seemed to be taking so many jobs out of the United States actually has made 69 percent of American households far wealthier than ever before.
You quote Yogi Berra in your book, “Still Stuck In Traffic,” as saying, “nobody goes there anymore because it’s so crowded.” Any solutions to traffic congestion, of which our region has its share?
Well, traffic congestion is not the problem. The problem is the way we organize society. Traffic congestion is our response to the way we organize it. We organize for economic efficiency purposes. Most people work at the same hours of the day; schools hours are the same.
But the price we pay for that is that everyone has to come home at the same time, too. There is no system of roads in the world to allow everyone to move at the same time. That’s why we have traffic congestion. Not only that, but as incomes and population go up, we add more and more vehicles. Between 1980 and 2000, for every one human being we added to the population we added 1.2 additional vehicles. At that rate, between 2000-2020 we’re going to add 38 million more vehicles to correlate with our population gain. Maybe more.
Congestion is only going to get worse everywhere in the world.
The best thing to do is get yourself an air-conditioned car with a DVD player, a good stereo and maybe even a microwave. And commute with someone you really like. Enjoy your time stuck in traffic instead of commiserating about it because it’s going to get worse.
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